Webster Financial Corp (WBS) 2005 Q2 法說會逐字稿

Good morning ladies and gentlemen. And welcome to the Wester Financial's second quarter conference call. [OPERATOR INSTRUCTIONS]

Also, this presentation includes forward-looking statements within the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 with respect to Webster's financial condition with results of operations and business and financial performance. Webster has based these forward-looking statements on current expectations and projections about future events. These forward-looking statements are subject to risks, uncertainties, and assumptions as described in Webster's financials public filings with the Securities and Exchange Commission. which could cause future results to differ materially from historical performance or future expectations.

I would now like to introduce your host for today's conference, Mr. James C Smith, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you. Good morning everyone and welcome to Webster's second quarter, 2005 investor call and webcast. Joining me today are Bill Bromage, our President, our Chief Financial Officer, Bill Healy , and Terry Mangan, Investor Relations. Others are here as well to respond to your questions after our formal remarks, which would take about 25 minutes. I will provide highlights of the quarter and Bill Healy will provide details on our financial performance.

As you have seen in our earnings release, we reported marginally higher net income for the quarter versus a year ago. Diluted EPS were down $0.06 per share, cash EPS for the quarter were down $0.05 per share and were $0.09 higher than GAAP EPS after deducting stock-based compensation of $0.03 per share and intangible amortization of $0.06 per share. Items of special note in the quarter, and their effect on EPS compared to the reported amounts that I just mentioned include: EPS included only $0.01 of security gains compared to $0.07 a year ago so, net of securities gains, EPS were flat year-over-year.

Also note that Q2 '04 net interest income benefited from the larger wholesale borrowings and securities portfolio in place during that quarter. The '05 quarter also included $0.04 per share of one-time costs related to our core systems conversion project. The net expenses related to our de novo branching program were $0.01 greater in Q2 '05 than a year ago.

The net interest margin of 332 is 30 basis points higher than a year ago. Roughly 2/3's of this improvement is due to our deleveraging in Q4 '04 which strengthened our balance sheet and improved our earnings quality. We have also seen about 10 basis points of margin improvement beyond the deleveraging benefit, as our deposit pricing elasticity has been favorable and our loan yields have improved.

Credit performance remaining strong with a net recovery of $300,000 in the quarter. This contributed to an increase of $2.3 million in the allowance per loan losses for March 31. Our loan portfolio totals $11.8 billion, and has grown by 5% over the past year. Commercial, including commercial real estate and consumer loans, have grown at a combined organic rate of 9% over the past year while (resis) have declined, as planned, by 1%. As a result, (resis) now comprise 40% of total loans compared to 42% a year ago.

Commercial originations were $495 million in the quarter compared to $443 million a year ago, and the commercial pipeline was 544 million at June 30 compared to 506 million a year ago. Consumer originations were $364 million in the quarter compared to $302 million a year ago. Mortgage originations were $864 million compared to $959 million a year ago.

Our deposits totaled $11.6 billion at June 30 and have grown by 12% from a year ago. DDA and NOW account balances have grown by 11% and 15% respectively, while CD's have grown by 20% as consumer preferences have shifted to this product category.

Our total core revenues, consisting of net interest income and non-interest income and excluding securities gains, were $183 million in the quarter, up 11% from a year ago aided by the FIRSTFED and HSA Bank acquisitions. Net interest income increased by 14% compared to a year ago due to our net interest margin improvement and 5% growth in interest earning assets despite a 14% reduction in the average level of the securities portfolio.

The core fee revenue categories of deposit service fees, insurance, loan and loan servicing, and wealth management, which Bill will talk about in more detail, have grown by 6% over the past year. We have been talking a lot lately about our guiding operating principals so I will discuss our second quarter performance in the context of these principles. We remain confident that we will achieve our tangible equity ratio target of 5.5% by year end and 6% by 2007. This ratio was 5.38% at June 30, up 67 basis points from 4.71% a year ago, and up 30 basis points from March 31. Bill will provide detail on specific items affecting capital in the quarter.

Our securities portfolio represents 22% of total assets, as it has since year end '04. This level is consistent with our expectation for '05, and approximately the median for our mid-cap commercial bank peer group.

Deposit growth of $1.2 billion over the past year has allowed us to reduce our reliance borrowed money by $950 million. As a result, borrowings as a percent of total assets declined to 23.7% at June 30 from 29.9% a year ago and 26.8% at March 31. This puts us under our year-end 2005 goal of 26%. Borrowings actually declined by $518 million in Q2, to $4.1 billion. We are pleased with this progress.

Our loan-to-deposit ratio was 109% a year ago, 111% at year end and has improved to 102% at June 30. We have made substantial progress against the median level for our peer group, which was 95% at March 31. Deposits from HSA Bank, as well as from our de novo branch expansion program, have helped us to meet already our year-end, 2005 loan-to-deposit goal of 107%.

During the quarter, we increased our use of treasury deposits, i.e. Eurodollar and (street) CDs, as an alternative method of funding by about $125 million from Q1. Our Q2 net interest margin of 3.32% held up quite well during the quarter, though the shape of the yield curve suggests some downward pressure into the 320s over the next two quarters. I call your attention to the retail-wholesale spread on the 5th page of the financial tables in our earnings release, where you will see the retail spread actually increased two basis points in Q2 to 4.09%, while the wholesale spread declined 21 basis points, understandably, to 1.08% on a dwindling book.

Our core expenses including the affects of acquisitions, higher expenses of about $1 million related to our de novo branch expansion program, and $3.5 million in one-time expenses from our core infrastructure conversion project, were $93 million in Q2 '05 compared to 89.3 million a year ago for an increase of about 4%.

Our efficiency ratio adjusted for securities gains, amortization expense, and one-time conversion expenses, was 57.4% for the quarter, which would place us right around the median for our peer group.

I want to comment briefly on some of our strategic investments. We expect to complete the core infrastructure project in Q3, and we currently expect one-time expenses to be about $7 million. This is an increase from the $5.8 million expected previously with the $2.4 million remaining balance of expense to be incurred in Q3. We look forward to our modern ASP platform with it's high reliability, efficiency, and scalability. The FIRSTFED conversion onto this platform, which we we delayed to minimize customer disruption, is now complete.

Regarding our de novo performance, we have opened three branches in Connecticut so far this year, Bridgeport and our second office in Norwalk during the first quarter, and Groton in April. These three de novo branches, and 11 others that preceded them, represent $397 million in deposits at June 30, compared to $299 million for de novo offices as of December 31. We now expect our total de novo deposits to be about $550 million at the end of '05, compared to 600 million that we expected previously. This reduction reflects less aggressive promotional pricing in de novo markets than originally contemplated and the direct contribution, we expect, will remain about the same.

We continue to expect to open five additional de novo branches over the remainder of this year. We expect about $5 million of incremental de novo costs for all of 2005 compared to 2004, $2.7 million of which have occurred in the first half of the year. We have about $190 million of deposits at HSA Bank, compared to 169 million at March 31, with deposits having grown by roughly 12% during the quarter. We continue to expect HSA Bank's deposits to be well over $200 million by this end of this year. HSA Bank accumulated over 47,000 accounts, in the first half of this year, already surpassing the nearly 45,000 new accounts that they opened in all of 2004.

Finally, what really stands out in our Q2 performance is the quality of earnings. Securities gains represented only 1% of earnings compared to nearly 8% a year ago. We gave up spread income that could have been earned by releveraging in favor of building the tangible capital ratio, and we invested in our future. This is a meaningful improvement in our core-earnings quality.

Let me now ask Bill Healy to expand on the financial report.

Thank you, Jim. And good morning to all of you joining us today. This was a quarter of solid performance in a difficult interest rate environment. It was highlighted by the high quality of core earnings, very strong growth in deposits, and continued reduction in our wholesale borrowings. I will focus my comments today, for the most part, on our (linked) quarter performance.

Some of the other key trends and highlights of the quarter that I will focus on are: strength in commercial and consumer loan growth fully funded by deposits; solid acid quality ratios with strong reserve and coverage ratios, and a net recovery for the quarter; an improvement of 30 basis points in the tangible capital ratio; modest core expense growth when you exclude the impact of acquisitions, strategic investments and non-core expenses related to our core systems conversion.

We also had 1.6 million of one-time items during the quarter consisting of write-downs's of $472,000 in mortgage-servicing rights and $325,000 in direct investments, and $800,000 of legal related expenses. Total revenues, excluding security gains, were 182.8 million in the second quarter and increased an at an annualized rate of 5%. Impacting this growth was the growth in net interest income which totaled 129.8 million in the second quarter compared to 128.2 million in the first quarter. The increase is due to a volume increase of 158 million in average earning assets while the margin of 3.32% was the same as in the first quarter.

Also contributing to our ability to maintain the margin during this period of yield curve flattening has been our capacity to entirely fund loan growth with lower costing deposits, as well as use excess deposits growth to reduce higher costing, short-term borrowings.

Non-interest income, excluding 710,000 in security gains, also grew at an annualized rate of 5%. For the quarter, core fee categories of deposit service fees, insurance revenues, loan and servicing fees, and wealth management grew at an annualized rate of 3%. Strength in deposit service fees and wealth management were offset by declines in insurance revenues and loan and servicing fees.

Deposit fees rebounded by 14% from the first quarter's low level, keeping in mind that the first quarter typically sees a seasonal decline impacted this year by a reduced level of NSF fees seen across the industry. The improvement in the second quarter came mostly on the strength of fees from HSA accounts and higher NSF fees and card fees.

Wealth management revenues increased by 12% from the first quarter as we saw strong investment sales from our retail broker-dealer network. Insurance revenue declined seasonally by 1.2 million, or 11% from the first quarter, which typically is the strongest quarter of the year. The decline from the first quarter was a bit steeper than what we had seen in prior years, as there was pressure on renewal pricing during the quarter in relation to the competitive environment.

Loan and loan servicing fees declined by 1.7 million. The decline included 1.2 million lower prepayment fees and a 472,000 write-down of mortgage servicing rights. On the expense side, our core rate of growth has slowed to our ongoing efforts to streamline processes and control the discretionary costs while we continue to invest for the future.

That trend is most obvious in Q2 when you look at our linked quarter comparisons. Non-interest expenses in the second quarter were 113.5 million and compared to 107.8 million in the first quarter. Adjusting each quarter for acquisitions, investments and de novo branch expansion and the core infrastructure conversion costs, core expenses grew at an annualized rate of 2%. When you further adjust for the $800,000 in legal expenses and 325 of direct-investment write-down in the quarter, this increase is about 1.4%.

The individual amounts in the second quarter for the various items, as compared with similar amounts in the first quarter, are as follows: de novo expenses were 2.6 million in Q2, the same as recorded in Q1; core infrastructure project expenses of 3.5 million in Q2, compared with 1.1 million in Q1; incremental expenses of 1.3 million from the First City and HSA Bank acquisitions are also included in this quarter.

Turning to asset quality, our combined measures of asset quality remain very strong given the risk profile of our loan portfolio. NPAs declined by 4.9 million from March 31st, and now total 44.2 million. The ratio of NPL's to total loans improved by 4 basis points from March 31 and total 35 basis points. The allowance was 1.31% of total loans at June 30, and represents 369% of non-performing loans compared to 334% at March 31.

We had a net recovery of $300,000 in the quarter that resulted from charge-offs being at their lowest level over the past 8 quarters and recoveries of 2.1 million. The net recovery and a provision of 2 million resulted in an increase of 2.3 million in the allowance from March 31st.

Turning to a review of the balance sheet, total assets of June 30 were 17.5 billion for growth of 3% compared to a year ago and flat compared to March 31. The investment securities portfolio continues to represent about 22% of assets. We continue to position the portfolio to anticipate rising rates and concentrate our efforts on purchasing short-duration securities like hybrid ARMs that will have minimal extension risks as interest rates rise. The average duration of the available-for-sale portfolio was 2.0 years at June 30, compared to 2.2 years at March 31. For the entire portfolio, including 1.2 billion of health and maturity securities, the duration was 2.8 years compared to 3.2 years at March 31. The portfolio yielded 4.62% during the quarter, up from 4.54% the prior quarter.

Available-for-securities unrealized losses at June 30 were 13 million compared to a loss of 32 million in March 31. Loan growth during the quarter was slower than we anticipated. Early prepayments were offset by growth late in the quarter, particularly in the commercial and consumer portfolios. As a result total loans grew, on average, $42 million compared with point-to-point growth of 114 million. Commercial loans grew by 107 million or an annualized rate of 16%. Middle market, asset-based, and equipment finance loans each grew by around 40 million while specialized loans declined by 16 million. Commercial real estate loans declined 1%, or 25 million, and totaled 1.7 billion.

We continue to see prepayments during the quarter as borrowers refinanced at favorable rates and terms predominantly in the loan syndication market. Residential mortgages also declined by 1%, or 33 million, and represent just under 40% of total loans as we allowed the portfolio to decline in this period of declining long-term rates. We would expect to see little to no growth for the balance of the year in this portfolio. Consumer loans totaled 2.7 billion, and increased at an annualized rate of almost 10% from the last quarter.

Growth of 63 million in the quarter partly reflects the new approval process implemented earlier this year. The new process allows us to reduce the time it takes to close the transaction while substantially improving the overall closure rate. Deposits increased by 547 million, or 5% during the quarter, after taking into account 48 million of deposits that were held at March 31 in the two Wisconsin branches that were divested on April 15. The increase came in the form across-the-board strength in demand deposits, NOW accounts, and retail CDs.

Our recently implemented funding diversification strategy, where we issued institutional CDs and Eurodollar deposits, represented about 125 million of the increase. Our tangible equity ratio increased by 30 basis points from March 31, to 5.38% at June 30 and reflects tangible equity growth of $53 million in the quarter. The 30 basis-points improvement in the tangible ratio represents 8 basis points from an improved FAS 115 mark, 23 basis points from net retained earnings, and a decline of 1 basis point from an increase in assets.

Our exposure of tangible capital to an upward shock in interest rates of 200 basis points is 43 basis points at June 30. This has been cut nearly in half compared to exposure of 80 basis points prior to our deleveraging program. From an overall interest rate sensitivity perspective, we continue to be relatively neutral to rising rates. For any parallel change in interest rates of plus 100, 200, or 300 basis points, the impact on (APS) would be minimal.

Our asset liability committee regularly reviews the impact of non-parallel shifts in the curve, which describes the current environment and we do have exposure to yield-curve flattening. Most likely is the flattening with the short end of the curve rising faster than the long end. In the scenario of the short end up 50 basis points from here, with no movement in the longer end, EPS would be reduced by about 2% over a year. Again, these scenarios assume no corrective action. Our ability to execute on our business plan to attract and grow low cost deposits, including through such initiatives as de novo branching and HSA, enables us to partially offset the impact of changes in the curve.

In closing, I thought I would provide you with our current view on our 2005 performance. Overall, we would expect no significant change in the 2005 growth rates of average earning assets and average loans from the guidance we provided you back in our call in April. Average earning assets should grow 5% to 6% while average loans should grow around 10% off the 10.7 billion full-year 2004 average. Assuming further yield-curve flattening of 50 to 75 basis points, our best guess is the net interest margin could decline over the next 2 quarters to somewhere in the low to mid-320's in the fourth quarter of this year. Total non-interest income, excluding security gains, should grow in the high single digits compared to a year ago, reflecting the recent, more favorable trends in deposit service charges.

No change in the core expense growth assumptions from our last investment call,, but as Jim indicated we do see our infrastructure and conversion costs increasing to around $7 million for the year. Virtually all of that remaining 2.4 million should occur in Q3. We expect favorable asset quality to continue. Overall, for the balance of the year, the provision could be in the 4 to $6 million range, and is expected to exceed our net charge-offs for the balance of the year.

Now, let me turn the program back to Jim for his closing comments.

Thank you, Bill. Webster's performance again shows solid progress under our objectives of a strengthened balance sheet, solid organic growth and high quality earnings while we confidently invest for the future. We continue to narrow the performance gaps that exist between Webster and the median of our mid-cap commercial bank peer group as we complete our transformation.

Q2 results reflect a continuation of the growth and momentum that many of you heard us speak about at our recent Investor Day. This was a solid quarter for us in a challenging interest rate environment. Not to be overlooked is that all of what we have achieved is rooted in the fact that our customers love us. Let me mention how a recent image study showed that customer's image of Webster is highest among all banks in the market, our loyalty scores highest among all banks in the market, and non-customers are 50% more likely to switch to Webster than to the next-highest-rated bank.

As we look ahead, we see a number of positive developments to augment our performance. The higher run rate cost of our new core systems will be offset by greater efficiency and by revenue from products and services our old systems couldn't readily accommodate. Additionally, the recent completion of the FIRSTFED conversion onto our new system, which we consciously delayed to keep the effects on our customers to a minimum, now will allow for realization of FIRSTFED conversion savings of about $2 million a year.

Our recent item processing conversion to Fidelity National will also generate savings in processing costs. In '06, incremental net expenses from continuing expansion of our de novo program will represent only about 1 to $2 million more than in '05, compared to a $5 million increase in '05 versus '04. Annual amortization of core deposit intangibles were reduced by an estimated $4 million in '06 followed by a further estimated reduction of $8 million in '07. Good things are happening at Webster.

Thank you for joining us today. We will now be pleased to take questions and comments.

Thank you, ladies and gentlemen. We will now be conducting a question and answer session. [OPERATOR INSTRUCTIONS] Our first question comes from Jared Shaw with KBW.

Good morning. Actually, just a few things. First is on the tax rate. It looks like this quarter it was lower than in the past. It was lower than we were expecting. What should we be using for a tax rate for the rest of the year and maybe looking out into '06?

Jared, at this point, I will just give you the rest of this year. It should be around 32%. And as far as next year, it should be not much off of that. I wouldn't say lower, but maybe a tad higher.

And then 32%, is that average for the year or is that, what -- for the next 2 quarters?

That is what it should be for the next 2 quarters.

Okay. And then, at the beginning of the year, you were on the capital -- on the tangible assets ratio -- you felt it would get to the 5.5% by the end of year. It looks like you are going to get there before that. Do you think that -- what would you do with that capital if you get there before the end of the year.

Well, at this point we still think we're going be at 5.5% at the end of the year.

And that is without doing -- or would that just be you going to be managing for 5.5%?

We think with the growth that I talked about in earning assets and loans for the rest of the year, we should be at 5% -- 5.5% at the end of the year.

Okay.

But I would expect the second quarter that we would be somewhere in the 540s and then 5.5 at the end of the year.

Jared, I want to add to that as the tangible capital ratio is growing faster than projected, it is possible that we could be higher than the 5.5 by year end which does open up some possibilities for us, including possibly on the acquisition side and even possibly on the stock-buyback side.

And then, just finally, on the IT conversion and on the new branches-- could you just give us an update on why the IT budget is coming in so much higher than originally expected?

I could just sum it up by saying that it is an issue of the cost of training, the number of people involved and the timing of the conversions themselves all added up to where the expenses are a million dollars or so higher than originally anticipated.

And then, as far as the de novos are concerned, we consciously decided to lower the relative promotional rates that we were paying and to take a slightly less total deposit level in exchange for an improved direct contribution. We could easily have achieved the original projection but we felt that, particularly in this interest rate environment, it was better to back down the promo rates and go for the direct contribution.

Just on the -- on those branches. I think I was confused with a few of the numbers. What has been the cost so far this year on branch expansion and what is the remaining on branch for the rest of the year?

I think we said it was around 2.7 higher in the first half than a year ago, and we expect another 2.3 or so in the Q's 3 and 4.

Okay. It is that two -- roughly 2.5 million -- for each of the next 2 quarters.

No.

Or combined?

Combined.

Okay. Thank you very much.

Our next question comes from Laurie Hunsicker with FBR. Please state your question.

Hi, good afternoon. If you could -- I guess to follow up on some of the things that Jared was touching on. Bill, if you could go back to the infrastructure conversion project expenses for a moment. Basically, that is going from 1.5 million to 2.4 million in 3 Q, and then -- is that correct?

That's correct. 1.1 million in the first quarter, 3.5 million in the second quarter and 2.4 million --

In the third quarter.

In the third quarter.

Which leaves us a residual of about 300,000 or so for a fourth quarter? And then --

Possibly.

And then from there it is going to be gone, correct?

Yes.

Okay. And then, you next went over some of the one time charges. I just wanted to clarify -- your direct investment write-downs in the legal expenses of 800,000 -- 325 and 800 -- those both sound like a non-interest expense?

Yes, the 325 is in the other category.

Okay.

And of the 800, there is 500 in other and 300 in professional.

Professional. Okay. And then looking at the other with the non-interest income. At 2 million that looked higher, and I wondered -- did you guys book a gain from the sale of the Wisconsin branches? Is there any kind of non-recurring gain that is embedded in that number.

No, we have been about $2 million all year, and I think in the last 2 quarters, we have been about at the $2 million level.

Okay. Because I had just remembered you had in the March quarter about a million or so non-recurring. Was I -- well I guess --

We did Laurie. We had a million dollar insurance recovery in the first quarter and we had about that in the second quarter too.

So that's a million dollars -- can we count that as non-recurring?

Yes.

Okay. Okay. And then, did you book any gain on the sale of the Wisconsin branches or no?

No.

Okay.

We took it as a reduction of our core deposit and tangible.

Okay. Perfect. And then, just two more questions. With respect to the loan loss provision bill, you mentioned that going forward -- I think I got this right -- for the year, be 4 to $6 million.

That is correct, over the next 2 quarters.

Okay. That makes more sense. Over the next 2 quarters. Okay. And then, just generally going back to Jim. Something you mentioned off of Jared's question -- possible buy-back or possible acquisition. Can you discuss a little bit for us again what you would look at in terms of size of acquisition and the realm of geography that you would consider (cleaving in two) or filling in?

Sure. We would look at contiguous acquisitions that would help us to expand the franchise. We would look at acquisitions within market that would help us to strengthen our position and have some consolidation potential.

I think we generally would be looking at something up to a couple hundred million dollars in value. And I am thinking that there may be some opportunities.

Okay. And just -- I am sorry, one more question. The branch that you all just opened -- that takes your Fairfield county branches up to 22. Is that correct?

You know, I don't have the precise number. I know it is close, but we will get back to you with the exact number.

You are still at roughly about a 5 or 6% deposit market share.

Roughly, yes.

And. just one more question. Would it be safe to assume that Fairfield county and Westchester county would most likely be your target markets? Obviously, that is where you are focusing de novo, but also on the acquisition front, if you were to go that route?

Well, it would be a market in which we would be interested. We are also interested in moving north. We are interested in building out our Mass and Rhode Island franchises as well. We are open to the opportunity of combining with like-minded partners that share our vision of being the leading financial services provider, and I think I wouldn't want to narrow it down much more than that.

Okay. Great. Thanks a lot, Jim.

Thank you.

Our next question comes from Tom Doheny with Sandler O'Neill. Please state your question.

Good morning, guys. Thanks for all of the detail. With regard to your overall goals, you are down below where you wanted to on the year end -- get the borrowing-to-assets. Where do you see that going longer term and what is going to drive that? What will be the drivers of that going forward?

Longer term, we will be less reliant on wholesale borrowings, and that will be achieved through the focus that we have on our deposit-gathering programs, whether you are talking about growing within market through our high-performance checking programs, our de novo banking programs, the HSA programs. All of those are contributing to a faster rate of growth in deposits which is fully funding our loan growth and then creating the capacity to pay down some wholesale borrowings. So we would see our wholesale borrowing ratio over time declining further from where it is.

And then, on the charge-off side it looked like the growth charge-off number came in a lot lower this quarter, but were there any really large recoveries this quarter on the commercial side that were bringing the overall net charge-off number negative here?

I can speak to that. This is Jo Keeler. There was nothing in terms of single, large size. It was just a combination of a number of 2 to 3 to 400,000 recoveries on work-outs of older credits.

On the provision guidance for the year -- just to make sure I have this right -- you were at 13 to 14 million full year previously and the full year now is -- I am sorry, I didn't have that in front of me.

The full year, Tom, would be somewhere between 9 and 11.

9 and 11. Great. And on HSA Bank, I know we had talked about a million-five in costs on that. Were you at really the full run rate of HSA expenses or so in the second quarter?

I think that as that continues to grow, we will continue to ramp it up, so I would expect that the expenses there would continue to grow over the next 2 quarters.

No question. Since you raised the HSA point, I would just say we have got about 120,000 accounts now all together with these deposits now closing in on $200 million. Our specialized call center is handling over 4,000 calls a week and, I am happy to say, with an average wait time of 11 seconds. We are processing over 14,000 deposits per week, so HSA is really making a lot of progress.

We just announced an online enrollment feature for individual accounts which will roll out for group accounts very shortly. And so yes, we do expect we will have higher operating costs as the balances increase.

Great, and then finally on the commercial real estate side you cited some prepayments in that portfolio this quarter but I noted at the analyst day, you were a little bit cautious with regards to that portfolio generally. Was that a contributor to what we saw as a lack of growth in the real estate portfolio as well.

Yes, and the fact is the market is very tough, spreads are tight. There is some structural deterioration we see in some places. There are lots of competitors in the market. We are actually -- given the circumstances -- we are very pleased with the progress we have made in that portfolio.

Great. Thanks a lot, guys.

Our next question comes from James Ackor with RBC Capital Markets. Please state your question.

Thank you. Good morning, guys. Thanks for the detail you are providing -- very helpful. Two questions, probably both for Jim, maybe one for Bill. Jim, with regard to asset quality -- obviously we are seeing pretty strong numbers industry wide. You guys are a pack in terms of NPAs and keeping all of that under control. But, you are also talking at the same time about very intense pricing competition and a lot of money chasing, particularly in the commercial real estate environment. At what point would you think we might expect to see a turn for the worst in credit for the industry? Not for you guys specifically, but for the industry?

Well, we always try to underwrite with the anticipation that there could be problems down the line, so we may not be the best people to request ask that question, but right now we don't see any real symptoms that there is going to be deterioration.

One thing is that some of the asset valuation that has occurred hasn't been quite as intense in a lot of the markets where we operate, so we don't have that same kind of risk. We are very careful about the way we structure own programs, so we are confident in how we perform in a deteriorating market. I don't think we want to predict when there is going to be a problem because there isn't a big problem right now in terms of the quality of the assets.

I think things would have to happen in the economy at large to have a negative impact that could cause that to occur. We will just continue to underwrite conservatively and manage aggressively.

Okay. Fair enough. Second question, with regard to sort of a core run rate for IT expenses, can you guys provide us with a number there? And then also, maybe for Jim, I am curious at how you guys go about looking at a complete overhaul of your systems -- internal systems -- and how you kind of measure the return on investment over time, or can that be done quantitatively?

I'll take the second question first -- Webster's transition from a thrift institution to a commercial bank financial services provider over the last 12 years or so. We held on to our old systems as long as we could because they were so efficient for us. But, at some point, you have to move up to the next level. That is what we have done here. We have undertaken this conversion. We have working on it for 15 to 18 months.

For the last three or 4 years we have built out the infrastructure of this bank to make us competitive with any organization in our market regardless of their size. And, we are very pleased with the progress that we have made. So, there is a fundamental decision that was made here well over a year ago, that it was time to move up to the next level, have the systems that give us the reliability, the potential for efficiency, the ability to generate revenue and, very important, the scalability that we would want to have going forward. And by working with Fidelity National -- who you know is the largest provider of ASP systems to the larger commercial banks in the United States -- we felt that would be the right way to go.

So we are willing to trade a somewhat higher run rate for the scalability, reliability and efficiency of the systems and also the ability to offer some high-level commercial banking products we otherwise would not have been able to offer. This was a fundamental decision we made that is moving us to a higher competitive level.

Okay. Good. And Bill, do you have a run rate for us, a core run rate for the IT expenses going forward once the incremental expenses are out of the way?

Do you want the run rate for all of the expenses in IT, Jim?

Yeah, if we could.

I don't have that handy, and I don't know that we would get into just discussing what our core run rate in that area would be. But the $7 million of one-time expenses are expenses that are truly that: nonrecurring and will go away once the conversion is complete.

About 7 million in total. Okay. Thank you.

Let me just say, in answer to an earlier question, it is 22 branches now in Fairfield County.

Thank you. Our next question comes from Bill McCrystal with McConnell Budd Romano. Please state your question.

Good morning. In regards to the home equity portfolio, I wonder if you would give us what the outstandings were at the end of the first half and, I guess more importantly, discuss some of the broader characteristics. Obviously with concern about a housing bubble and rising rates, can you speak to a little bit about the underwriting process, what kind of shock you put into the underwriting from a rate perspective and just generally how comfortable you feel about the outlook for the portfolio going forward.

Okay. As far as balances, Bill, the total consumer portfolio was about 2.7 billion. Included in that 2.7 billion would be about 1.6 billion of lines, 900 million -- 990 million equity closed-in loans and the rest would be just other consumer loans that we have acquired over the years from our various acquisitions.

With respect to the -- the process we use in terms of sourcing underwriting loans in the -- home equity loans and I think implicit in that is the concern perhaps about -- is there a housing bubble and are we exposed to that. We have been working hard in terms of enhancing our equity lending. We have quick approval process where we have gotten our approval rates up to in the 80% range. We have got a sizable portion approved on a next day basis. That has helped us with closing and pull-through rates, so we have seen some pick up in terms of our lending in market, particularly through our retail branches, and there is a very good partnership between our consumer lending group and our retail bank, and that is paying dividends for us.

We have also introduced flex pricing. I think if we have made a stated objective that we would like to increase the yield in this portfolio over time. We have a very clean portfolio today, and if you look at the charge-offs in this portfolio, quarter over quarter over quarter we are typically in the 1 to 2-basis point range over an extended period of time. So we think we have done a superior job in terms of our underwriting and our risk characteristics in this portfolio. In some respects, frankly, maybe a little too clean in the sense that our yield on this book isn't as high as it could be, and hence we are looking at the flex pricing.

Having said that, today we are still seeing the average FICO score, month in and month out, are in the 720 to 740 range. Loan to values on a combined basis are in the 70 and 80%. We have very little exposure over 90 or 95%.

So from a risk parameter, or risk characteristic perspective, we feel that the portfolio is in a strong condition and we like it there. We don't think that we are exposed to a bubble at this point. We keep very close track at what is happening in the housing market across many sectors in our portfolio, including this.

But I think that the underriding characteristics and the strength of the team processing these mortgages has been very -- these equities has been very strong, and we look to continue to build that book, and also to shift the profile a little bit to get more yield out of it.

Okay. Thank you. And then, I just wanted to go back to the earlier comments regarding acquisitions. At the analyst day, Jim, I believe you put the priority of acquisitions fairly low, and I don't know if this is just my interpretation of comments here, but it seems to me that there's a slight shift between what you were saying at the analysts day versus where we are today. Is that correct or am I just misinterpreting.

Our focus is on organic growth, it is on the balance sheet, it is on high quality earnings. I think that, out of that, and the progress that we have made and potentially higher valuation will come opportunity that might not otherwise have been available.

Okay. That's fair enough. Thank you.

We have got moved it in our order of priorities. We intend to grow through organic growth.

Thank you. Our next question comes from Matthew Kelley with Moors and Cabot. Please state your question.

Yeah, hi guys. Just a question on getting back to provisions and kind of ask the quality and coverage ratios. You folks are one of the only ones that have actually held the line in terms of your coverage ratios as a percentage of total loans. We have not seen the bleeding that we have seen with other companies. And, I am just kind of curious going forward is that 1.3% level a level that will be maintained kind of give even some of your earlier commentary about where we are maybe in the credit cycle (of the biz). It's held pretty consistent at that level.

I appreciate you making that comment about the quality of our earnings, Matt, because it is so true that we are provisioning well beyond what we are charging off in any given quarter. We are anticipating our changing credit profile as we go forward. And so, again, it is a reasonably conservative way to approach this.

We have said, I think, pretty clearly that we expect that our ratio ought to be somewhere in the, say, low to mid-120's up to the low to mid-130's or so. So, we are kind of in the middle of the range. We have some latitude if we chose to use it. Mostly, we are trying to reserve based on what we really think we need to protect the loan portfolio that we have at any given time. But, it is clear that there is some flexibility there.

Okay. Second question was you had mentioned some of the growth metrics on the HSA accounts. I believe it was 20 million -- $21 million in net growth from Q1 to Q2 to get up to, like 190. I was wondering if you would just comment on the average cost of those deposits. I know there is a stage when they come on the books that they are maybe a little higher, and then they kind of ramp down over time. Maybe you could just remind us of what you are paying on those accounts.

I think the average cost of the portfolio is somewhere around 2% at this point. And the way that we set it up is we have tiered pricing and we pay very low rates on the first few hundred dollars and then we have a breakpoint, I think, at 1500 and 2500. I think we will find that it is likely that the average cost of those deposits will hold stable even though rates are rising -- is what we would expect over the next six to 12 months or so.

We are not leading with premium pricing as the means by which we attract the accounts but rather by the quality of the service that we provide and the ability to service the accounts and the employers that sign up with us.

Okay. And then, last question. Bill had given some commentary on the margin for the remainder of the year. I wonder if you would care to comment on how that could progress into early '06 in that same environment of 50 to 75 basis points -- more flattening, I believe, was the premise there.

I think I made a comment in my remarks, assuming you get plus-50 or so, that the impact on EPS over a 12-month period would be about 2% negative. I don't think I would want to try to get any more definitive than that right now. That is looking about a year or so out.

Okay. Thank you.

Thank you.

Our next question comes from Faye Elliott-Gurney with Lehman Brothers. Please state your question.

Hi. Thanks for taking my call.

Sure, Faye.

In terms of the the margin, you talk about -- and I know you just reiterated it -- you are assuming that there is 75 basis points more of flattening throughout the rest of the year, and that is how you get to the 320 -- low 320, mid-320 range for 3 Q and 4 Q?

Yes, pretty much.

Okay. And, what else did I have? Oh, also --

I am going to say Faye, I don't want to be too precise about this. Let us say 50 to 75.

50 to 75?

Yes.

So your -- and then, the securities portfolio that you are investing in because you have had such strong deposit growth -- it hasn't been too much -- but where are you putting those securities? What types of securities are you buying?

Generally we are buying hybrid ARM's, five-one ARMs with a duration of maybe 2.5 to 2.8 years.

Okay. Great.

And I think you probably noted, in an earlier comment, that the duration of the securities portfolio has declined between March 31 and June 30.

Great. That's all I have got now.

Thank you.

Thanks.

Our next question comes from Kevin Timmons with C.L. King.

My questions were answered, guys. Thank you very much.

Thank you, Kevin.

Ladies and gentlemen, there are no further questions at this time. I will now turn the conference back over to your hosts to conclude.

I just want to thank you all for being with us today and for your interest in Webster. I look forward to seeing you or talking to you again soon.

Thank you ladies and gentlemen, this does conclude today's teleconference.